Wednesday, January 13, 2016

High-Risk Low-Reward?

Is it true that high risk = high reward? Maybe not. In a recent full-page ad in Forbes magazine Fidelity shows that between 1985 and 2015 ten different industry groups did not necessarily perform as their risk characteristics would have predicted. What was the riskiest--by far--of the 10 industry groups? Technology, of course. How did technology perform? Only #6.
Ouch. That right there pokes some holes in the notion that high risk = high return. But, we aren't done yet. The highest-returning industry group was health care. Where did it rank in terms of risk? Third from the bottom. Yes, the highest-returning industry group was also one of the least risky. Consumer staples was second from the bottom in terms of risk, yet it ended up second from the top for performance! What if one had invested in the least risky of all groups, utilities--surely, he would have ended up at the bottom for performance, right? Wrong. The least risky of all groups, utilities, still came in #7, just a hair behind technology, for performance. Think about that for a minute! Not only would taking on the highest-risk group not have gotten you high performance, but also, it would have gotten you just barely ahead of the lowest-risk group, utilities.
I'm not sure if technology is the most disappointing of all ten industry groups, or if we should nominate financials for that dubious honor. Financials--banks, insurance, broker-dealers, etc.--surely this was a lower-risk and higher-reward group, right? Actually, it was #4 in terms of risk but only #8 in terms of performance. No, on second thought, materials was the worst industry group. Materials was #2 in terms of risk but ended up second-from-the-bottom for returns. As I scan the excellent illustration in this full-page ad, I note that not one of the 10 industry groups ranked the same in risk as it did in reward. The one that came closest to doing that was consumer discretionary, which was #3 in risk and #4 in return. But, still, healthcare and consumer staples beat out #3, #4, and #5 by around 4 percentage points over 30 years! And, again, both industry groups were at the bottom of the pack in terms of risk.
Basically, no matter how I look at these numbers, all I can conclude is that the high-risk, high-reward myth has been soundly . . . busted. Need help on the Series 7?

2 comments:

Hi - do you have any books or other compilations of your test prep questions?

I'm also wondering if you continue to respond to comments on older posts? I have a question I submitted to this post: http://passthe7.blogspot.com/2010/03/felonies-and-finra-registration.html Thank you!

I forgot to update the email address to which comments were (supposed) to be forwarded. Oops. I'll look at your other comment. The products are available at www.examzone.com. You can get just the ExamCram questions, or add the DVDs, and/or the textbook. I recommend all three.